London Hedge Funds Are Betting a $100 Carbon Price Is Almost Here

(Bloomberg) -- Andurand Capital Management is among hedge funds betting the price of carbon can only go up.

Brussels is enacting plans to eliminate carbon emissions by the middle of the century in a massive shift in how the European Union powers its economy. Forcing up the bloc's carbon price, one of the key tools of EU climate policy, may be crucial. The higher the price, the more incentive companies have to make the hard decisions needed to tackle global warming.

“We're very confident the price path forward is up,” said Casey Dwyer, an analyst at the energy and oil-focused hedge fund run by Pierre Andurand. “We have an aggressive target for where we think prices need to go.”

Dwyer expects it will hit 100 euros ($121) per metric ton of carbon emissions, possibly as soon as later this year, from about 33 euros now. Andurand, one of the best-performing hedge funds in 2020, is joined by Lansdowne Partners LP and Northlander Commodity Advisors in predicting a surge this year. Some of Europe's biggest banks are also signaling demand for credits will grow in coming years.

If they're right, the players on the upside of the trade could make millions. At the same time, higher prices for emitting carbon will force companies to invest in green technologies that would otherwise be deemed too expensive. The idiosyncrasy of the carbon market as an extension of government policy means hedge funds speculating on carbon could help accelerate companies' move toward net-zero.

Unchartered Territory

Not everyone is so bullish and the fact the EU can step in to temper market swings makes it even harder to call.

“We're in uncharted territory. You don't have strong checks in place that would send prices lower,” said Marcus Ferdinand, head of European carbon and power analytics at ICIS. “I wouldn't put a max level. I see 40 euros as possible this year, but that doesn't rule out higher levels.”

Even if speculation spurs a price rally, it may only be temporary. And a rally that gets out of hand could be clipped by EU policy makers. While Brussels is at war with carbon emissions, it also wants its industries to thrive and stay competitive.

If the price goes too high, too fast, the EU can intervene to protect companies that can't transform fast enough.

The EU's cap and trade system, the world's largest carbon market, covers more than 11,000 energy-using facilities such as power plants, steel producers and chemical plants. The idea is that companies can pollute, but they need to pay for it, giving those that can cut emissions an advantage.

After the market launched in 2005, prices briefly surged as high as 31 euros in 2006. Prices then languished for a decade after the 2008 financial crisis.

Reforms in recent years revived interest. One measure to do that, known as the market stability reserve, started removing credits that would have been auctioned off starting in 2019, reducing a surplus of credits and boosting the price.

Some investors took notice and piled back in, spurring a 206% rally to 25.01 euros in 2018. Last year, the price jumped to as high as 33.50 euros, defying the slump in industrial output and emissions brought on by the pandemic.

The shift came as EU Commission President Ursula von der Leyen pegged the region's economic recovery to the green transition. Now the EU is once again looking at mechanisms to squeeze the market.

“It's the best time to invest since early 2018,” said Ulf Ek, chief investment officer at Northlander. Prices need to rise for the system to achieve its goal of reducing pollution, he said.

Ek was among the few early players in the market who saw how the regulatory shift would squeeze supply and push prices higher. This year he expects carbon will go as high as 50 euros, and then 70 euros by 2025.

Going Beyond Utilities

The surge in prices is necessary for emissions to fall faster. Most EU pollution cuts so far have been in the power sector. The carbon price has helped make cleaner gas plants financially more attractive than burning coal.

With plans to phase coal out completely in the coming decades, the EU is focusing on other industries that are harder to clean up. One major strategy is the use of hydrogen made from renewable energy that could replace fossil fuels in chemicals and steel plants, as well as long-distance transportation.

“It's no longer utilities that are price setters, it's the other sectors,” said Per Lekander, fund manager at London-based Lansdowne.

He sees carbon prices between 50 euros and 100 euros per ton within a year or two, partially boosted by demand from steel, cement and airlines. Anything below 50 euros would be too low to meaningfully influence any industry outside the power sector, he said.

More Investors

Hedge funds also expect more institutional investors to dive in.

Late last year, Goldman Sachs Group Inc. created what it calls a Carbon-Neutral Commodity Index, which would allow investors to invest in commodities like oil and offset the emissions by also buying EU carbon permits. EUAs are the third-largest holding in the index after WTI and Brent crude oil.

A spokesperson for Goldman Sachs declined to say if any institutional clients had started investing according to the index, but they see demand for something like it.

“Bottom line, every institutional money guy I talk to wants a strategy like this,” said Jeff Currie, head of commodities research at Goldman Sachs.

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